IRS Reduces Compliance
Burden on Small Businesses
The IRS has issued Revenue Procedure 2000-22, which permits businesses with average gross receipts of $1 million or less to use the cash method of accounting even if the taxpayer would otherwise be required to use the accrual method due to the presence of inventories. This change is effective for tax years ending after December 16, 1999.
To qualify for the favorable treatment granted by Revenue Procedure 2000-22 two tests must be met: a gross receipts test and a conformity test.
Qualifying for the Cash Method
Gross receipts test. The three-year average gross receipts must be calculated after the end of each year for a taxpayer and all related entities that have been in existence for three years or longer. If the average for the three prior years exceeds $1 million, the taxpayer is not eligible for the cash method of accounting.
When the entity has been in existence for less than three years, the average annual gross receipts is determined by the number of years the entity has been in existence. Any short-period receipts must be annualized. For purposes of the test, gross receipts include all sales net of returns and allowances (but not cost of goods sold), all service income, interest, dividends, capital gains, rents, and royalties, plus any income from incidental or outside sources.
The procedure requires the aggregation of the gross receipts for all entities treated as a single employer under the provisions of sections 52(a), 52(b), 414(m), and 414(o). Section 52(a) includes brother, sister, and parent-subsidiary groups as defined in section 1563(a), except that a more than 50% stock ownership test is substituted for the more than 80% stock ownership test. Section 52(b) aggregates trades or businesses under common control whether or not they are incorporated. Sections 414(m) and (o), which define commonly controlled entities for the purposes of calculating limitations on the work opportunity credit and retirement plan benefits, were enacted to limit the taxpayer’s ability to divide activities between entities so as to maximize the work credit and pension benefits of business owners. For example, a sole proprietor who also owns more than 50% in a partnership must aggregate the gross receipts of the proprietorship and the partnership.
Conformity test. The conformity test requires regular use of the cash method of accounting for book and reporting purposes for the current and prior three tax years. Reporting includes any financial statement or other report provided to owners, beneficiaries, or creditors. If a taxpayer uses the cash method for tax purposes but issues a financial statement on the accrual method the conformity test would not be met. Isolated violations of the conformity rule are disregarded (for example, a one-time accrual statement in order to obtain a bank loan).
Assuming a business qualifies for (and, if applicable, elects) relief under Revenue Procedure 2000-22, it can—
Making the Conversion
Taking advantage of the benefits of Revenue Procedure 2000-22 is simple for new businesses and for existing cash method businesses that can satisfy the gross receipts and conformity tests.
For accrual method taxpayers, however, the process is more involved. For qualifying taxpayers that can satisfy the gross receipts and conformity tests, Revenue Procedure 2000-22 grants automatic consent to change to the cash method of accounting if the procedures of Revenue Procedure 99-49 are followed [with the modifications provided in Revenue Procedure 2000-22, section 6.02(l)]. A Form 3115 (Change in Accounting Method) must be filed with the first tax return for which the cash method is used, and a copy of Form 3115 must be sent to the IRS National Office. Form 3115s filed under this revenue procedure should include the notation “Filed under Revenue Procedure 2000-22” at the top of page one.
If a qualifying accrual basis taxpayer has already filed its 1999 return on or before July 15, 2000, an amended 1999 return along with a Form 3115 can be filed to elect the cash method for 1999. The amended return must be filed no later than November 13, 2000. Additionally, a copy of the Form 3115 must be filed with the IRS National Office no later than the date the amended return is filed.
The section 481 adjustment, which is required as a result of changing to the cash method of accounting and making any necessary change to the taxpayer’s inventory method (including the discontinuance of capitalizing inventory costs under IRC section 263A), is normally taken into account over four years.
Converting back. If the taxpayer initially qualifies for the relief but subsequently fails either or both of the $l million gross receipts and conformity tests, the taxpayer must use an appropriate inventory method and, in all probability, convert to the accrual method of accounting, at least for the sale and purchase of merchandise. Such a change will qualify for the automatic consent provisions of Revenue Procedure 99-49 (or its successor), which means that Form 3115 must be filed with the tax return for the year of change and a copy sent to the national office. The section 481 adjustment from such a conversion back to the accrual method would normally be recognized over four years.
Edwin B. Morris, CPA
Rosenberg, Neuwirth & Kuchner
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